Commercial Real Estate CRASH is Coming!! Why I'm Worried!

Commercial Real Estate: The Catalyst for the Next Global Financial Crisis?

In this video, the speaker discusses commercial real estate and its potential impact on the global financial crisis. They define commercial real estate and explain how it differs from residential real estate. They also discuss the different types of commercial real estate and their varying levels of risk.

What is Commercial Real Estate?

• Commercial real estate refers to any real estate that isn't residential.

• Multi-family rentals, such as condos, are considered safer investments compared to other types of commercial real estate because they are similar to residential properties.

• Office spaces and other types of commercial real estate are higher risk because they may not always be in high demand.

The Impact on the Economy

• The US commercial real estate sector is worth over 20 trillion dollars, but only around 5.5 trillion dollars of that is in loans.

• Most commercial real estate loans have adjustable interest rates, which means they become more expensive as interest rates rise.

• Roughly 1.5 trillion dollars of the 5.5 trillion dollars in loans will be refinanced at a higher interest rate over the next year or so.

• Around 3.5 trillion dollars of debt is related to everything else besides multi-family rentals, which is causing concerns due to its exposure to banks and shadow banks.

The History of Commercial Real Estate

• During the pandemic, commercial real estate initially looked like it was going to suffer but quickly recovered after investors were able to refinance their debts at lower interest rates.

• However, when the Fed started raising interest rates again, over-leveraged investors went bankrupt.

• The sector had the capacity to survive the squeeze so long as the Fed didn't raise interest rates any higher than seven percent, but then the banking crisis happened.

Overall, commercial real estate is a complex and risky sector that could potentially have a significant impact on the global financial crisis. It's important to understand its nuances and potential risks before investing in it.

The Impact of the Banking Crisis on Commercial Real Estate Lending

This section discusses how the banking crisis affects commercial real estate lending and why banks are less likely to lend to commercial real estate investors.

Banks' Guarantee and Commercial Real Estate Loans

• Banks will be less likely to lend to Commercial Real Estate Investors.

• Commercial real estate loans are not liquid, making it difficult for banks to sell them if customers withdraw all at once.

• Multi-family rentals are expected to be fine, but office spaces may face challenges due to the work from home trend.

Exposure of Small and Medium-Sized Banks

• Office space market in Los Angeles is already down over 40 percent.

• Between 70 and 80 percent of commercial real estate loans come from small and medium-sized banks.

• Large banks restricted real estate lending after the 2008 financial crisis, leading small and medium-sized banks becoming popular sources of funding.

Shadow Banks' Involvement in Commercial Real Estate

• Wells Fargo is the largest office space lender.

• Shadow banks operate with next to no oversight or regulation, making them risky sources of funding for commercial real estate investment firms.

• Private investment firms like Blackstone have defaulted on commercial real estate loans.

Unpacking the Relationship between Shadow Banking Sector and Commercial Real Estate

This section explains how private real estate investment firms try to avoid marking their assets to market by preventing any selling because the value of their assets may decrease.

Private Real Estate Investment Firms' Strategy

• Private real estate investment firms are trying to avoid marking their assets to market.

• They prevent any selling because the value of their assets may decrease.

• This strategy is risky and can lead to defaults on commercial real estate loans.

Shadow Banks' Role in Commercial Real Estate

• Shadow banks provide funding for private real estate investment firms.

• They operate with next to no oversight or regulation, making them risky sources of funding for commercial real estate investment firms.

Risks Associated with Commercial Real Estate Investment

• Investing in commercial real estate is risky due to the lack of liquidity and potential market fluctuations.

• Investors should be cautious when investing in commercial real estate and consider the risks associated with it.

Private Real Estate Investment Funds and the Shadow Banking System

The value of FTT was artificially kept high by FTX, which collapsed after FTT crashed. Private real estate investment funds are primarily invested in by pension funds and non-profits. If there is a crisis in the shadow banking system due to commercial real estate loans, pension funds could be hit hard.

Investing in Private Real Estate Investment Funds

• According to James and Shalom, private real estate investment funds are primarily invested in by pension funds and non-profits.

Non-Recourse Commercial Real Estate Loans

• Most commercial real estate loans in the US are non-recourse. This means that if a borrower defaults on a loan, they only lose the property; they don't owe the difference if the property went down in value.

• Given the status of most office spaces today, a loss is essentially guaranteed. There are estimates that office spaces will lose half of their value in the coming years.

Collapse of Non-Multi-Family Commercial Real Estate

• The upcoming collapse of non-multi-family commercial real estate could have significant implications for the housing market depending on how it unfolds.

• Small and medium-sized banks may start selling their commercial real estate loans to honor customer withdrawals during bank runs, causing prices to crash and potentially leading to issues in the shadow banking sector.

• Private real estate firms like Blackstone hold lots of residential real estate, so any contagion in the shadow banking sector would hit pension funds hardest.

Potential Solutions

• The Fed may set up a facility like BTFP but for commercial real estate loans to allow small and medium-sized banks to borrow against their commercial real estate loans at their full value to honor customer withdrawals.

• Alternatively, the Fed could encourage banks to continue providing credit to the commercial real estate sector by offering loan extensions. This would prevent the commercial real estate sector from collapsing and in turn prevent issues in the shadow banking sector.

The Future of Commercial Real Estate

In this section, the speaker discusses the potential future of commercial real estate and how it could impact the housing market.

BlackRock's Potential Purchase of Commercial Real Estate Loans

• The pension for commercial real estate is likely to be larger than insulating the shadow banking sector.

• BlackRock may buy commercial real estate loans from Signature Bank and SVB because office spaces can be converted into multi-family rentals and residential real estate.

• Converting commercial real estate can be expensive, but if prices drop low enough, it could become economically viable to do so.

• McKinsey recommends embedding digital solutions in everything, which could lead to converting office spaces into smart city-compatible condos and apartments.

Increase in Housing Supply

• Conversions will happen, causing housing prices to drop due to an increase in housing supply.

• Vacant retail and office spaces are being offered as condo and apartment rentals because they were originally residential.

• If interest rates don't come down soon, then the commercial real estate sector will crash. Regardless of interest rates, some niches like office space are still doomed.

Conclusion

• An increase in housing supply will bring costs down and possibly result in a housing dystopia.